Version A

I. Multiple Choice

(1)f. (2)e. (3)a. (4)c. (5)b. (6)b. (7)b. (8)b. (9)b. (10)b.

II. Problems

(1) [Measuring industry concentration: 18 pts]

1. Firm 1.
2. 80.
3. 90.
4. Industry B.
5. 3000.
6. 2100.
7. Industry A.
8. 0.15 .
9. 0.105 .

(2) [Entry barriers and contestable markets: 26 pts]

1. $2.
2. 6 million.
3. 2/3 = 0.667.
4. $3.
5. $4.
6. loss.
7. $3 million.
8. 9 million.
9. $2.
10. profit.
11. $27 million.
12. $2.
13. 0, since P = MC.

(3) [Dominant-firm price leadership: 30 pts]

1. $4.
2. $10.
3. 1 million.
4. 10 million.
5. Residual demand is a straight line, has vertical intercept at P=$10, and touches market demand curve at $4, according to answers to parts (a) and (b) above. Slope is therefore = 1 / 2 million.
6. Residual demand is a straight line, with same intercept and twice the slope as residual marginal revenue. Slope is therefore = 1 / 1 million.
7. 8 million.
8. $6.
9. 2 million.
10. 2/3 = 0.667 .

II. Critical Thinking

A credible threat is one that a firm has an incentive actually to carry out. This particular threat by Firm A is not credible, because if Firm B were to enter the market, Firm A would have no incentive to lower below its average cost, because in doing so, Firm A would make losses. Since Firm B has the same costs as Firm A, there is no reason to believe that a price war would induce Firm B to exit the market any sooner than Firm A.

Version B

I. Multiple Choice

(1)e. (2)f. (3)c. (4)a. (5)a. (6)a. (7)d. (8)c. (9)a. (10)a.

II. Problems

(1) [Measuring industry concentration: 18 pts]

1. Firm 7.
2. 70.
3. 70.
4. Equally concentrated.
5. 1600.
6. 2200.
7. Industry B.
8. 0.08 .
9. 0.11 .

(2) [Entry barriers and contestable markets: 26 pts]

1. $3.
2. 7 million.
3. 4/7 = 0.571.
4. $4.
5. $7.
6. loss.
7. $9 million.
8. 8 million.
9. $3.
10. profit.
11. $24 million.
12. $3.
13. 0, since P = MC.

(3) [Dominant-firm price leadership: 30 pts]

1. $2.
2. $9.
3. 3 million.
4. 8 million.
5. Residual demand is a straight line, has vertical intercept at P=$9, and touches market demand curve at $2, according to answers to parts (a) and (b) above. Slope is therefore = 1 / 2 million.
6. Residual demand is a straight line, with same intercept and twice the slope as residual marginal revenue. Slope is therefore = 1 / 1 million.
7. 6 million.
8. $6.
9. 4 million.
10. 0.5 .

II. Critical Thinking

Same as Version A.

[end of answer key]